Policy Uncertainty Hurting Growth Prospects

U.S. Overview

Optimism May Be Running Ahead of Political Reality

While the geopolitical landscape has changed mightily, the post-election jumps in consumer confidence and business optimism may be a little overdone. Our forecast for U.S. economic growth is little changed from what we were looking for prior to the election. The risks are now more toward the upside, given that the Trump presidency is likely to push forward significant tax reform, reduced regulatory burdens for many businesses and some additional spending on defense and infrastructure. These changes will not occur immediately, however, and the eventual composition may look much different from the rhetoric expressed during the campaign.

The transfer of power is expected to produce only minimal impacts on the near-term economic outlook. We estimate that the economy grew at just a 1.2 percent pace during the fourth quarter, as the widening trade deficit subtracted 1.2 percentage points off that quarter's growth rate.

After growing just 1.6 percent in 2016, we look for real GDP to rise 2.3 percent this year. Consumer spending is expected to rise solidly, benefitting from stronger wage gains. Business fixed investment is also expected to perk up, with a rebound in oil exploration helping drive equipment purchases. Homebuilding should also grind higher, although rising mortgage rates will limit the extent of any gains.

We look for inflation to move modestly higher, which will keep the Fed in the hawkish camp. We look for the Fed to raise the federal funds rate twice in 2017.

International Overview

Policy Uncertainty Hurting Growth Prospects

Although we have started to see some improvement in economic indicators across the global economy, the uncertainty surrounding the speed of future monetary policy changes by major central banks could keep global economic growth contained, at least in the near term. This is especially true as the Federal Reserve continues to normalize interest rates and the ECB grapples with its own monetary policy decisions in the face of increasing inflation. There also is uncertainty regarding the outlook for fiscal policy, especially in the United States, but many investors seem to expect that U.S. fiscal policy will become more expansionary over the next few years. Whether it actually will has yet to be determined.

Policy uncertainty is also affecting other countries' decisions before President-elect Trump takes office in the U.S. For example, Argentina is considering going to the international financial capital markets to issue debt before Jan. 20 to try to pre-empt any market reaction to the U.S. political transition and to try to get a lower interest rate on debt issuance.

Meanwhile, Mexico is experiencing serious social upheaval due to the government's decision to raise gasoline prices in January due to the effects the depreciation of the Mexican peso is having on the cost of imported gasoline and on the country's fiscal deficit. Each time President-elect Trump makes a comment regarding his policies toward Mexico, the peso weakens and, in some instances, the Mexican central bank has been pushed to intervene in the foreign exchange rate market to support the peso.

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